CFA Level I · CFA Level I Exam · Pricing and Valuation of Options
A European call on a stock that pays a known dividend before expiry is analyzed using put-call parity. Relative to the no-dividend case, the parity relationship most likely requires that:
The present value of the dividend must be subtracted from the stock price. Option holders do not receive dividends, so parity becomes c + PV(X) = p + S0 - PV(D). The dividend lowers the stock's relevant value for the option, which raises put values relative to calls.
- Athe present value of the dividend be added to the stock price
- Bthe present value of the dividend be subtracted from the stock priceCorrect
- Cthe dividend be added to the strike price at expiration
Explanation
With dividends, c + PV(X) = p + S0 - PV(D). Holders of options do not receive the dividend, so the stock's effective value to an option holder is reduced by the dividend's present value. Adding it would reverse the effect.
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